Bernanke Unlikely to Bail Out Wall Street

As I watch late-breaking financial news and listen to the pundits, bloggers and such I still believe it likely that Bernanke will do a better job than did Greenspan in guiding US monetary policy. This is no time to flood the world with money as it will just hyperinflate bubbles. Bernanke is no dummy, and can't be cowed by a wounded, lame-duck Bush Administration. Russ Winter opines similarly (without the political commentary) in Fork in the Road, Part I and Part II. Winter's posts are worth reading if only to see where he (and I) differ from Doug Noland and a bunch of others on this matter.

Financial Sense's Jim Puplava put together an excellent discussion with Doug Noland [August 25] about conditions in the Ponzi finance credit markets. Noland mentions various indicators (bank credit, ABS commercial paper outstanding, junk bond issuance) that he is watching closely. These of course are the same ones we watch. Noland gives an historical synopsis of how credit creation has been shifted to the Wall Street sphere and to speculative finance (what I call wildcat finance to make a semantical distinction).

About three fourths of the way into the interview both gentlemen come to what I call the "fork in the road". Puplava characterizes this as "central banks printing money wily nilly". Noland makes remarks that indicates that he knows who has really been "printing the money" (in essence creating securities), and that’s the aforementioned Wall Street financial sphere. But, then he goes on to predict that in due course central banks will "pump new liquidity" into the system to the tune of one trillion dollars. He doesn’t think it will work.

This "fork" is where I depart company with Puplava and Noland (both of whom I respect), and no doubt with many others. First, any actions by key central banks have been temporary in nature, at least so far. There WERE massive injections of temporary liquidity in August, but they have largely been reversed, and just as quickly. In other words there have been no permanent injections at all, and in fact the Fed itself actually removed or sold securities from their SOMA. A temporary injection is not the same as monetization. To this juncture there is little evidence that central banks are running amok, the trends are flat lined. …

[C]learly the normal feedback loops and mechanisms of money creation (credit securities) are NOT in play. In fact, a strong case could be made that they are reversing, which is what one would expect when confidence in Ponzi units is shattered and few want to hold American Plague garbage. Today if Ponzi units were actually marked to market, the numbers on various forms of capital right now would really be shocking. The numbers being reported on bank credit, commercial paper, derivatives and other fictitious capital most certainly represents mostly mark to model or mark to make believe, and thus are grossly overstated on balance sheets and elsewhere.

Noland is right about one thing though, the pressure on the central banks and Fed to monetize is now even greater than it was in 1998 and 2001, the last times they applied standard Bubble blowing monetary policy. It's easy to see why people think it will be applied now. However, I suggest that conditions are very different this time around. I have been repeating the Martin Meyer quote from his book "The Fed" over and over and over. And here it is again, tattoo it on your forehead

"The truth is that liquidity, the only significant weapon remaining in the central bank’s arsenal as decision making moves to the markets, will not necessarily go where you want it to go when you need it to go there."

Translated in today's context this means that if central banks started an aggressive monetization process, it would immediately be transmitted by both investors and speculators towards Bubbles that are still strong or "in play". …

Update:

Ken Rogoff seems to agree, but goes on to suggest that a series rate cuts will follow, arguing that Bernanke may not like the engagement with financial markets but will accomodate them anyway as he attempts to stem damage on Main Street in the wake of coming corrections:

The Fed v. the Financiers: … I foresee a series of interest rate cuts by the Fed, which should not be viewed as a concession to asset markets, but rather as recognition that the real economy needs help.

In a sense, a central bank's relationship with asset markets is like that of a man who claims he is going to the ballet to make himself happy, not to make his wife happy. But then he sheepishly adds that if his wife is not happy, he cannot be happy. Perhaps Bernanke will soon come to feel the same way, now that his honeymoon as Fed chairman is over.

I still think that Bernanke has to think twice re: asset (and other) hyperinflation possibilities.

Comments

[Bailey]

After reading the Jackson Hole papers linked via Calculated Risk Blog & then rereading your latest (plea), I'm upping my odds the FED will delay cuts beyond its next meeting to 10%! Make no mistake, I wholeheartedly agree with your assessment. I just see NO evidence Gentle Ben is capable of looking Paulson in the eyes & telling him, ENOUGH IS ENOUGH, THIS NONSENSE STOPS HERE & NOW!